India's Rate Cut Has Got Consumers Excited

Gaurav Prakash, a private equity associate in his late 20s, working in India's financial capital Mumbai, recently shelved plans to purchase his first home in the city, given burdensome interest rates, however, the latest move by the Reserve Bank of India (RBI) has rekindled his interest in getting back into the market.

"I would be looking for a place in the range of rupees 2-3 crores ($370,000-556,000), so changes in interest rates have a huge impact in the way that I look at purchasing a property...loans are a very important part of financing it," Prakash, who recently got married and is looking to buy a home, told CNBC.

The RBI lowered interest rates by 25 basis points to 7.75 percent on Tuesday for the first time in nine months, in addition to a 25 basis point cut to the cash reserve ratio for banks to 4 percent. The central bank has been reluctant to reduce interest rates due to persistent inflation, despite weak GDP (gross domestic product) growth - which languished near a 3-year low in the third quarter of 2012.

India's closely watched wholesale price index (WPI) which has eased over the past three months, impacted RBI's latest decision. However, it is still well above the RBI's comfort zone of 4-5 percent.

Boost to Consumer Sentiment

While the single rate cut may not have a sizable impact on bringing down borrowing costs, it will provide a sentiment boost for Indian consumers, said experts, pointing to the property and auto sectors as the primary beneficiaries of policy easing. The two industries are particularly sensitive to changes in interest rates as purchases are largely financed through bank loans.

"The rate cut may build expectations of an easing cycle...demand for more real estate and automobile loans will start increasing marginally," said Rahul Bajoria, economist at Barclays. He forecasts 100 basis points in rate cuts over 2013.

India has among the highest lending rates of the world's major economies. Benchmark interest rates in large emerging markets such as China and Brazil, for example, stand at 6 percent and 7.25 percent, respectively.

Between 2010 and 2011, India's central bank aggressively tightened monetary policy, hiking rates 13 times to 8.5 percent as growth began to recover following the global financial crisis. In April 2012, it lowered rates by 50 basis points to boost economic activity, but paused thereafter despite mounting pressure to lower borrowing costs and boost growth, which fell to as low as 5.3 percent last year.

Samantak Das, director, research and advisory services at Knight Frank India agreed that more than the impact on borrowing costs, the RBI's 25 basis point rate cut sends a positive "signal" to potential home buyers.

High home loan rates and worries over economic growth have weighed on the country's housing market in the past year. During the first half of 2012, home sales witnessed steep declines of 40 percent in major cities, including Delhi, Mumbai and Bangalore - compared to the preceding six months - local media reported, citing real estate services firm CBRE.

"This is a good trigger. Because the real estate sector is rate sensitive the market believes that any rate cut will help push demand. From a customer's point of view this will improve liquidity and reduce the interest burden," JC Sharma, managing director, Sobha Developers, Bangalore told Reuters.

Das, who foresees 150-200 basis points cuts in the next 12 months, however, believes it will take some time before the market sees a large pick-up in transaction volumes as buyers hold off purchases in anticipation of additional easing.

In order to see a material increase in sales volumes, rates would need to fall around 200 basis points, he added. Home loans are currently at an all-time peak, according to Jones Lang La Salle, at around 11 percent.

For the auto market, Mohit Arora, executive director at J.D. Power and Associates, said it is a similar picture. "Seventy percent of all car purchases are made through loans, so it does impact sentiment there."

While a reduction in car loan rates - which currently stand around 10 percent - will do little to boost luxury car sales, as buyers are less price sensitive, Arora said it would benefit sales of mid-price range cars from makers Hyundai and Honda.

India's auto market has been under pressure from falling sales in recent months as the economic slowdown, rising ownership costs and high interest rates curb demand. In November, for example, car sales fell over 8 percent from a year earlier.

While the RBI's rate cut is a step in the right direction for generating demand in the two sectors, analysts said a more notable boost to consumption will come about if January's rate cut evolves into an easing cycle.

The central bank did hint in its quarterly monetary policy review that growth risks would be given greater emphasis in monetary policy, kindling hopes of a possible start to the cycle.

"The Reserve Bank of India is definitely less hawkish in its statement, and we think it will remain in the easing mode in 2013, " Sujan Hajra, chief economist, Anand Rathi Securities in Mumbai told Reuters.